Investment Commentary – April 2020

The impact of the Coronavirus (COVID-19) outbreak will likely deliver a sharp and deep global recession in 2020, due to the stringent social distancing measures put in place to contain the spread of the virus and “flatten the curve”. While there are a variety of views from market economists on how long it will take to recover from the shutdown, the consensus is that the global economy should be in recovery by mid-2021.

Economic stimulus measures strive to keep economies going

The Australian Federal Government has responded with an extraordinary level of economic support to “build a bridge to the other side” of the crisis. Inclusive of the JobKeeper Payment costing $130 billion over six months, the Federal Government has so far announced direct fiscal payments of around $215 billion (approximately 11% of GDP).

The Reserve Bank of Australia (RBA) cut the cash rate to a new record low of 0.25% in March. Other measures include an unprecedented bond buying program to inject liquidity into the financial system and reduce borrowing costs. According to RBA Governor Philip Lowe, the economic damage caused by the virus will be severe, however it will be temporary and does not represent a change in the fundamentals of the Australian economy. By implication, once the virus has been contained, our economy should recover strongly. Low interest rates and a weak Australian Dollar (AUD) will assist with this.

These measures have been mirrored around the world with many countries pledging to do “whatever it takes” to support their economies. In the United States of America (USA), the government announced a support package valued at around USD $2 trillion (approximately 10% of GDP). The USA’s Federal Reserve has also acted aggressively with an open-ended program to buy bonds to keep credit flowing in the real economy.

Market response

The Australian share market (S&P/ASX 200) fell around 37% during February and March in one of the fastest sell-offs ever, making it a challenging time for investors. Internationally, share markets have taken a similar hit, but the depreciation of the AUD has thus far helped to buffer losses on offshore assets.

While markets have rallied since the fiscal and monetary support measures, volatility remains high because of the residual uncertainty regarding the length of time economies will be shut down and whether stimulus measures will be enough. It will take time for actions by governments and central banks to have their effect. Another recent factor worth noting is the oil price war resulting from the Russia-Saudi Arabia breakdown, which has heavily impacted the energy sector, further destabilising investment markets.

Australian investors do not have all of their portfolio in shares, so actual losses in a diversified portfolio over this period have been more modest.

Anticipated impact

Based on previous downturns in 1992 and 2008-09, company dividends are expected to fall around 30% on average, before rebounding when the economy recovers. While this may pose issues for investors relying on investment income for their living needs, in a diversified portfolio, defensive investments such as cash and fixed interest could be used to top-up income payments. Despite dividend cuts, it is worth noting the dividend yield on Australian shares/Real Estate Investment Trusts (REIT), which currently sits at around 5% p.a. on forward-looking basis, is still significantly higher than is available on other sources, such as term deposits and bonds.

Look long term and remain focused on your investment strategy

For anyone willing to take a long term view, the S&P/ASX 200 represents attractive value at a 12-month forward Price to Earnings ratio of around 12.7 times (compared to the 10-year average of 14.5 times). While earnings estimates will continue to be revised downwards over the coming months, long term investors can arguably look through the crisis to the eventual recovery in earnings. Certainly, the long run risk/return outlook for Australian shares has significantly improved in comparison with the pre-crisis multiple of over 18 times earnings.

What is different is that active stock picking will be more important than in recent years. Critically, companies need to have sufficient capital to get through the downturn. It is also important to consider the competitive landscape as the post-virus economy is likely to be structurally different because of lasting modifications in consumer behavior. For instance, the crisis is likely to accelerate the trend towards e-commerce as consumers are forced to get used to shopping for goods and services online, with implications for traditional retailers and certain property investments.

Aside from a health check on the individual holdings in your portfolio, the best approach in dealing with the crisis will be to avoid pressure to make wholesale changes to your investment strategy. Moving to a more defensive strategy now, after markets have declined, locks in a capital loss. While prices may fall further, it is important to recognise that financial markets are forward looking. By the time the news improves in regards to infection rates and the economy, prices will have already started to recover. This makes market timing very difficult to execute well, because waiting for sentiment to improve before investing invariably involves missing opportunities.

In summary, despite the current uncertainties, investors should remain focused on their long term investment strategy. As has been the case in previous market cycles, investors who can hold through the downturn are rewarded with above average returns in the long run.

If you would like to discuss the impact of COVID-19 on your investment strategy, please contact a BDO Private Wealth Adviser today.